SYDNEY: Australia's central bank cut interest rates by a quarter point to 4.25 percent on Tuesday as tamer inflation at home allowed it to take out some policy insurance against the debt crisis engulfing Europe.
The Reserve Bank of Australia's (RBA) easing was the second in as many months and came as analysts trimmed forecasts of economic growth amid an increasingly threatening global outlook.
"The board concluded ... that the inflation outlook afforded scope for a modest reduction in the cash rate," RBA Governor Glenn Stevens wrote in a brief statement following the central bank's monthly policy meeting.
Europe's woes were squarely in the bank's sights, with Stevens warning that "the likelihood of a further material slowing in global growth has increased".
He noted that trade in the Asian region was already showing the dampening effects of Europe's slowdown, while financing conditions had tightened across world markets.
Markets had been pricing in a 65 percent chance of a rate cut this week, and still imply further cuts in February and March next year. Economists had been more divided with 11 of 19 polled by Reuters tipping a cut of a quarter point.
"The cut is very much a function of global risks and the potential for spillover to Asia and Australia," said Su-Lin Ong, a senior economist at RBC Capital Markets.
"We have got another 50 basis points of easing in 2012. The way things are shaping up globally, the move to a more accommodative stance is appropriate."
Europe only accounts for around 7 percent of Australia's exports directly but the slowdown there is proving a drag on Asia. China alone takes 26 percent of Australia's exports and its economy has cooled to the point where the People's Bank of China took a first step toward easing policy last week.
The stress in global financial markets is also pushing up the cost of funding for major local banks, even though they are among the highest rated in the world.
Standard & Poor's on Monday stepped up the pressure on Europe by warning it could downgrade 15 euro nations, including top-rated Germany and France. Australia could soon be one of a very small clique of triple-A sovereigns.
PATCHY GROWTH
The RBA's decision came as many analysts were forced to trim forecasts for gross domestic product (GDP) for the third quarter, which is due out on Wednesday.
Analysts had been looking for growth of around 1 percent in the third quarter, compared to the previous quarter, but that might be ambitious now.
Data out Tuesday showed Australia's government had slashed spending by far more than expected last quarter, just a taste of the fiscal tightening needed to get its budget back to surplus.
"The government spending figures were very soft and it has to be a consideration for the central bank that a sector that accounts for a fifth of the economy is going backwards," said Brian Redican, a senior economist at Macquarie.
The drop in spending implied a 0.6 percentage-point cut to GDP, which followed a similar drag from international trade as import volumes outstripped exports. Combined with a steep 1.1 percentage-point hit from a rundown in inventories and the risks to growth looked to be to the downside.
Still, Australia's resource-rich economy also has plenty of strengths. Business investment surged last quarter thanks to the booming mining sector, while company profits, sales and wages all pointed to underlying health.
A record-high terms of trade helped narrow the country's current account deficit in the third quarter to A$5.64 billion, the lowest in over a year. The surplus on goods and services alone hit a record high of A$6.8 billion in current dollars, lifting national income.
Unemployment remains historically low at 5.2 percent -- a level that much of Europe and the United States could only dream of -- and inflation is well under control. Household saving rates are also at decade-highs, making the economy less vulnerable to financial shocks.
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